Forex Trading Psychology

June 21, 2015

As much as 80% of successful trading behaviour can be attributed to the mindset that the trader applies to their position-taking and risk management activities. In other words, trader’s psychology is what makes the difference when it comes to securing profits at the currency trading.

This article will tell you more about the correct mindset you need to have before engaging in the FX trading.

Read it now and find out what are the main obstacles and opportunities that might be hidden in your mind.

What is Trader’s psychology?

Trading differs from many other fields of endeavour in that even the best trading systems can be sabotaged by the introduction of the human element of psychology. When participating in the process of trading, you often become your own worst enemy.

To put it simply, the more removed you are emotionally and the more level-headed your demeanour when trading, the more likely that you will have what it takes to be a successful trader.

Planning, Trader’s Discipline and Flexibility

Interestingly, studies show that a trader’s mindset accounts for as much as 80% of their successful trading behaviour. This is true for good reason, since being a successful trader does not just come from knowing how to buy and sell in the market, but lies instead in knowing oneself well enough to produce the discipline needed to adhere to the rules set forth in a trading plan.

Regardless of how good your trading system may be on paper, in reality, the system is really only as good as the discipline of the trader who is actually implementing it. If you only follow your trading system partially, then it will only be partially effective.

Nevertheless, many successful traders are flexible in some aspects of their trading, often in the exact level of taking profits for example, and this flexibility can be a key element contributing to their overall success.

Reaction Plans

Knowing how one will react in the event of an adverse outcome for a trade is a good example of an advantage that a seasoned trader has versus a novice who is just learning how to trade or who has never traded before.

For example, a trader who takes a position that immediately loses money has two options:

They can hold the trade and wait for the market to reverse, or

They can liquidate the trade promptly and take a small loss.

Depending on the circumstances and their level of confidence in the trade, a seasoned trader would most likely either liquidate the failing trade immediately or might instead hold the position for a short period of time and then liquidate it soon after if the market did not turn around.

On the other hand, a less-experienced person would tend to hold the trade and not exit it within a certain period in the hope that the market might turn around to make the losing trade profitable.

Hope and Fear

The two emotional elements most obviously involved in the above example are hope and fear. The experienced trader rightly fears losing more money than they already have, and so they manage the trade accordingly by acting quickly to cut their losses in order to keep a clear enough head to be able to objectively re-evaluate their research before entering the market again.

Conversely, the inexperienced trader often foolishly relies on hope rather than on reason by thinking that the market might turn around in order for them to recover the money they had risked and even perhaps make a profit.

The psychology in the case of the inexperienced trader is flawed in that they should properly be in fear of losing more money and so should act or prepare to liquidate the failing trade.

By improperly replacing reasonable fear with unreasonable hope, they have in effect self-sabotaged and so they will probably not be able to think clearly because they are staring at a loss in their trading account.

As the loss grows, so does their hope which is now mixed with fear. Nevertheless, the fear of losing more seldom wins out versus the hope of breaking even.

In contrast to the novice, the experienced trader has already liquidated the losing trade and is now prepared to enter the market at a more favourable level. Furthermore, if the expert trader is sufficiently flexible from a psychological perspective and has fully admitted their trading error, they might even choose to reverse their position by taking a trade in the opposite direction from that of the original unsuccessful trading idea.

The Greed Trap

Another common human emotion that can be the bane of a trader is greed, or the desire to accumulate more than you need or deserve. This powerful desire can be especially problematic for traders when it causes them to avoid taking profits on winning positions at appropriate times.

Many market movements, such as overvalued price bubbles for example, are exaggerated by the greed of the herd of traders, and so most of those traders end up getting slaughtered when the bubble bursts.

Unfortunately, the materially-based Western society has conditioned its members to be greedy, and so many traders with that cultural background are not well-prepared to eliminate this emotional issue since it is an accepted element in their society.

Entering the often financially brutal world of trading can be a rude awakening to those whose psychological tendencies toward greed can very well lead to the failure of their trading business. This is why, most of the succesfull investors spend ton of time improving their trader’s psychology.

Contrarian Tendencies May be Beneficial

Another interesting fact is that overcoming unproductive psychological tendencies by trading a proven plan with complete and unwavering discipline is not the only way that many successful traders have made their fortunes. They will often tell you themselves that it was their capacity to avoid being caught up in trading along with the crowd that gave their profitability the biggest boost.

Such contrarian traders who are able to overcome the common psychological tendency to go along with the herd might instead choose to buy when the world is selling excessively on a wave of pessimism, or they might sell into a frenzy of optimistic buying at the end of a business cycle or speculative price bubble.

Forex Money Management

Money management is another very important factor to take into account when developing a trading plan that will help you overcome any psychological tendencies that might get in the way of your long-term profitability.

Since trading is not much different from gambling, when going into a trade or bet you really need to know exactly how much you can afford to lose in order to manage the funds in your trading account properly. This gives additional parallels between forex psychology and gambling psychology.

By deciding in advance what portion of your portfolio you are willing to risk when trading, you can better determine what size of position is appropriate for you to take on each trade, and hence ensure your long-term survival in the trading business.

Basically, understanding and managing your trading psychology to give you the strongest chance of success as a trader is vital. In fact, it may be one of the most important steps you can take toward ensuring your long-term survival in the business of trading.

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